Question
Both Firm A and Firm B earn 10 per share every year in perpetuity and have an annual required return on equity of 10%. Firm
Both Firm A and Firm B earn £10 per share every year in perpetuity and have an annual required return on equity of 10%. Firm A pays out all of its earnings to investors. Firm B retains half of the earnings and pays the other half to its investors.
Suppose that the ROE is 15% for Firm B. The first dividend will be paid one year from today. Calculate the current share price for both Firm A and Firm B. Discuss why the two prices are different.
Suppose that Firm A decides to follow Firm B by retaining half of its earnings and paying out the other half to investors. However, its ROE is 9%.
Calculate its new share price and compare it to the original share price. Why is it different?
Step by Step Solution
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Step: 1
To calculate the current share prices we can use the formula for the present value of perpetuity PV ...
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Foundations of Financial Management
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
10th Canadian edition
1259261018, 1259261015, 978-1259024979
